China is reverting to credit stimulus after attempts to engineer a stock market boom failed horribly. The day of reckoning is delayed again

By Ambrose Evans-Pritchard

8:51PM BST 22 Jul 2015,

The Chinese central bank is being forced to run down the country's foreign reserves to defend the yuanPhoto: Alamy

China is engineering yet another mini-boom. Credit is picking up again. The Communist Party has helpfully outlawed falling equity prices.

Economic growth will almost certainly accelerate over the next few months, giving global commodity markets a brief reprieve.

Yet the underlying picture in China is going from bad to worse. Robin Brooks at Goldman Sachs estimates that capital outflows topped $224bn in the second quarter, a level "beyond anything seen historically".

The Chinese central bank (PBOC) is being forced to run down the country's foreign reserves to defend the yuan. This intervention is becoming chronic. The volume is rising. Mr Brooks calculates that the authorities sold $48bn of bonds between March and June.

Charles Dumas at Lombard Street Research says capital outflows - when will we start calling it capital flight? - have reached $800bn over the past year. These are frighteningly large sums of money.

China's bond sales automatically entail monetary tightening. What we are seeing is the mirror image of the boom years, when the PBOC was accumulating $4 trillion of reserves in order to hold down the yuan, adding extra stimulus to an economy that was already overheating. The squeeze earlier this year came at the worst moment, just as the country was struggling to emerge from recession. I use the term recession advisedly. Looking back, we may conclude that the world economy came within a whisker of stalling in the first half of 2015. The Dutch CPB's world trade index shows that shipping volumes contracted by 1.2pc in May, and have been negative in four of the past five months. This is extremely rare. It would usually imply a global recession under the World Bank's definition.

The epicentre of this crunch has clearly been in China, with cascade effects through Russia, Brazil and the commodity nexus. Chinese industry ground to a halt earlier this year. Electricity use fell. Rail freight dropped at near double-digit rates. What had begun as a deliberate policy by Beijing to rein in excess credit escaped control, escalating into a vicious balance-sheet purge. The Chinese authorities have tried to counter the slowdown by talking up an irresponsible stock market boom in the state-controlled media. This has been a fiasco of the first order. The equity surge had no discernable effect on GDP growth, and probably diverted spending away from the real economy. The $4 trillion crash that followed has exposed the true reflexes of President Xi Jinping.

Half the shares traded in Shanghai and Shenzhen were suspended. New floats were halted. Some 300 corporate bosses were strong-armed into buying back their own shares. Police state tactics were used hunt down short sellers. We know from a vivid account in Caixin magazine that China's top brokers were shut in a room and ordered to hand over money for an orchestrated buying blitz. A target of 4,500 was set for the Shanghai Composite by Communist Party officials. Caixin says the China Securities Finance Corporation - a branch of the regulator - now owns an estimated $200bn of Chinese stocks and has authority to buy a further $500bn if necessary to prop up the market. This use of "brute force" - in the words of Peking University professor Michael Pettis - has done the trick. Equities have recovered. How could they not do so, since selling was illegal, and not to buy was also illegal? Yet it is hard to see what remains of Xi Jinping's pledge at the Communist Party's Third Plenum in 2013 to let market forces play the "decisive role" in the economy. There was always a contradiction in this pledge. Mr Xi was touting free enterprise, even as he tightened control on the internet, academia and political dissent. His failure to see through his reform strategy is fatal for China's economy. The World Bank and China's Development Research Centre - the brain-trust of premier Li Keqiang - published a long report three years ago calling for a market revolution before the Chinese economy hits a brick wall.

It warned that the country's 30-year growth model is obsolete. The low-hanging fruit of state-driven industrialisation has been picked.

Either China breaks its dependence on export-led growth and imported know-how or it will drift into the "middle income trap" awaiting all catch-up countries that fail to reform in time, and to make this fundamental break it must relinquish political control over the economy and let a hundred flowers bloom. "The role of the private sector is critical because innovation at the technology frontier is quite different in nature from catching up. It is not something that can be achieved through government planning," it said. Lombard Street Research says China's true economic growth rate is currently below 4pc, using proxy measures of output. Capital Economics and Oxford Economics have reached a similar verdict with their own tracking systems.

The legacy effect of pervasive excess capacity - the country produced more cement between 2011 and 2013 than the US in the entire 20th century - has been a blanket of deflation. Factory gate prices are falling at a rate of 4.6pc. Mr Dumas says this has pushed one-year market borrowing costs to 10pc in real terms. "Current monetary conditions are extremely tight," said Mr Dumas. The Chinese authorities have until now been reluctant to flood the system with fresh stimulus, all too aware that the ratio of private credit to GDP has jumped sixfold to 160pc of GDP since 2007. This is already far beyond any safe level for a developing economy and has lost its potency, in any case. The extra growth generated by each yuan of new loans has dropped from a ratio of 0.80 in the pre-Lehman era to 0.24pc today. The trade-off has become toxic. Adam Slater from Oxford Economics says the raft of easing measures since late 2014 have not kept pace with tightening conditions. The real exchange rate has jumped 15pc since mid-2014, chiefly due to China's dollar peg and Japan's yen devaluation.

"If the authorities wanted to quickly and radically ease monetary conditions, exchange rate depreciation would be the obvious way to go," he said.

This relief is blocked - for now - because it would risk other nasty side-effects. Chinese companies have $1.2 trillion of US denominated debt. A yuan devaluation would anger Washington and risk a beggar-thy-neighbour currency war across Asia, with lethal deflationary effects.

Mr Slater says China may instead have to slash interest rates to zero and even resort to "monetary-financed deficit spending" in the end, knowing that this stores up an even greater crisis later.

The early signs are that Mr Xi will now revert to stimulus again - hoping that he can calibrate the dosage, despite the Party's failure to do so on every previous phase of the stop-go cycle - concluding that it is too dangerous to let market forces do their worst after such vast imbalances have accumulated.

The Communist Party still controls the quantity of credit through the state banking system. It is using the power it knows best. New loans jumped to $205bn in June, up from $145bn in May. Local governments - facing new curbs on bank borrowing - issued a further $113bn in bonds. Taken together, they amount to a sugar rush of fresh credit.
Industrial output and electricity use are coming back from the dead. Sales of property floor space are suddenly spiking.
The great scare of early 2015 appears to be over. The hideous denouement has been averted once again. Mr Xi will surely discover that it won't be any easier next time.

“I am sure the euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created.”

– Romano Prodi, EU Commission president, December 2001

Prodi and the other leaders who forged the euro knew what they were doing. They knew a crisis would develop, as Milton Friedman and many others had predicted. It is not conceivable that these very astute men didn’t realize that creating a monetary union without a fiscal union would bring about an existential crisis. They accepted that eventuality as the price of European unity. But now the payment is coming due, and it is far larger than they probably anticipated.Time, as the old saying goes, is money. There are lots of ways that equation can work out. We had an interesting example last week. Europe and the eurozone pulled back from the brink by once again figuring out how to postpone the inevitable moment when all and sundry will have to recognize that Greece cannot pay the debt that it owes. In essence they have borrowed time by allowing Greece to borrow more money. Money, I should add, that, like all the other Greek debt, will not be repaid.I’ve probably got some 40 articles and 100 pages of commentary on Greece and the eurozone from all sides of the political spectrum in my research stack, and it would be very easy to make this a long letter. But it’s a pleasant summer weekend, and I’m in the mood to write a shorter letter, for which many of my readers may be grateful. Rather than wander deep into the weeds looking at financial indications, however, we are going to explore what I think is a very significant nonfinancial factor that will impact the future of Europe. If it was just money, then Prodi would be right – they could just create new economic policy instruments, whatever the heck those might be. But what we’ve been seeing these last few months is symptomatic of a far deeper problem than can be addressed with just a few trillion euros, give or take.But first, I’m going to reach out and ask for a little help. I have just signed an agreement with my publisher, Wiley, to do a new book called Investing in an Age of Transformation. I’ve been thinking about this book for many years, and it is finally time to write it. As my longtime readers know, I believe we are entering a period of increasingly profound change, much more transformative than we’ve seen in the past 50 years. And not just technologically but on numerous fronts. There are going to be substantial social implications as well. Imagine the entire 20th century fast-forwarded and packed into 20 years, and you will get some idea of the immensity of what we face.Now think about investing in this unfolding era of change. Companies will spring up and disappear faster than ever. Corporations will move into and out of indexes at an increasingly rapid rate, making the whole experience of index investing – which constitutes the bulk of investing, not just for individuals but for pensions and large institutions – obsolete.Just as we wouldn’t think of relying on the medical technology of the early 20th century, I’m convinced that we need a significantly new process for investing that doesn’t depend on the concept of indexing created deep in the last century. In an age of exponential change, being wrong in your investment style will no longer mean you simply underperform: you will not merely be wrong; you will be exponentially wrong.Of course, the flipside is that if you get it right, you will be exponentially right. We will be exploring some new investing concepts in Thoughts from the Frontline as I write the book, since this letter is actually part of my thinking process. I’ve been spending a great deal of time lately exploring new ways of thinking about the markets, different ways to manage risk, and strategies to take advantage of overwhelming change.This project will be significantly more complex than any book I’ve attempted so far. I’m looking for a few research interns or assistants to help me on various topics. Some topics are technological in nature, and some are investment-oriented. You can be young or old, retired or working in any number of fields; you just have to be passionate about thinking about the future and be able to spend time exploring a topic and going back and forth with me through shared notes and conversations. It’s a plus if you write well. If you are interested in exploring a topic or two, drop me a note at transformation@2000wave.com, along with a resume or a note about your background, plus your area of interest. Now let’s jump to the letter.

The More Things Change

Almost four years ago, in an article on Bloomberg with the headline “Germany Said to Ready Plan to Help Banks If Greece Defaults,” we read this paragraph:“Greece is ‘on a knife’s edge,’” German Finance Minister Wolfgang Schäuble told lawmakers at a closed-door meeting in Berlin on Sept. 7 [2011], a report in parliament’s bulletin showed yesterday. If the government can’t meet the aid terms, “it’s up to Greece to figure out how to get financing without the euro zone’s help,” he later said in a speech to parliament.Over the last few weeks he took a similar hard line, offering the possibility that Greece could take a “timeout,” whatever in creation that is, and only the gods know how it could work for five years.Reports of the final meeting before the agreement with Greece was reached demonstrated that there is little solidarity in the European Union. The Financial Times offered an unusually frank report of the meeting:After almost nine hours of fruitless discussions on Saturday, a majority of eurozone finance ministers had reached a stark conclusion: Grexit – the exit of Greece from the eurozone – may be the least worst option left.Michel Sapin, the French finance minister, suggested they just “get it all out and tell one another the truth” to blow off steam. Many in the room seized the opportunity with relish.Alexander Stubb, the Finnish finance minister, lashed out at the Greeks for being unable to reform for half a century, according to two participants. As recriminations flew, Euclid Tsakalotos, the Greek finance minister, was oddly subdued.The wrangling culminated when Wolfgang Schäuble, the German finance minister who has advocated a temporary Grexit, told off Mario Draghi, European Central Bank chairman. At one point, Mr Schäuble, feeling he was being patronised, fumed at the ECB head that he was “not an idiot”. The comment was one too many for eurogroup chairman Jeroen Dijsselbloem, who adjourned the meeting until the following morning.Failing to reach a full accord on Saturday, the eurogroup handed the baton on Sunday to the bloc’s heads of state to begin their own an all-night session.”That meeting ended with Angela Merkel and Alexis Tsipras arguing for 14 hours and giving up. Donald Tusk, the president of the European Council (and former Polish Prime Minister), forced them to sit back down, saying, “Sorry, but there is no way you are leaving this room.”Essentially, they were arguing over what form of humiliation Greece would be forced to swallow.For all intents and purposes, Greece had to surrender its sovereignty and is now a European protectorate. But in the end, a majority of the Greek parliament agreed that was better than holding hands and stepping off the cliff into the abyss. In the wake of all my reading this past week on the topic, and after a lengthy conversation with George Friedman of Stratfor, let me offer some thoughts.Europe as a free trade zone essentially works. It is not perfect, as no free trade zone is, but it is far better than the alternative. However, the eurozone has been an utter disaster for most of its members. It has been a triumph for Germany.Germany now exports almost 50% of its GDP, with half of that to its fellow European Union members. Germany has prospered with a far weaker currency, the euro than it would have with its deutschmark. The southern members of the eurozone (including France) have suffered with a far stronger currency than they deserve.George Friedman argues (quite aggressively) that the Germans were bluffing. The idea that Greece might lead the eurozone panics German leaders, since they know that if other members were also to leave, their export market share would begin to erode.I agree with George that there is a two-speed Europe that is trying to make a single monetary policy work for dramatically different economies. If you were to split the eurozone into several different currency zones, the zone that contained Germany would soon see its currency appreciate, perhaps dramatically, against the currency of its southern peers.The vision of a European Union as something more than a trade zone is one for Euro-romanticists. It’s a political vision, not an economic one. And during the meetings in mid-July, the political reality crushed economic reality. No one really thinks that Greece can repay the debt it has incurred. Greece was once again forced to agree to a deal that will let it to borrow more money that it can’t pay in return for hobbling its economy even further.Why would Greece do this? Especially after the people voted overwhelmingly not to take a deal that was somewhat better? Because if they simply walked away from the debt and returned to the drachma, then every Greek pension would have to be paid in drachmas. Grexit would almost immediately cut the lifestyle of every person on a pension in half. And whatever we may think about the situation in Greece, Greek pensions are not all that generous.Greece has to import nearly all of its pharmaceuticals and medical supplies, all of its energy, and most of the bits and pieces needed to run its machinery and businesses. By contrast with Germany’s, Greece’s exports are less than 15% of its economy. Greece is already at the critical point in the medical arena, with most drug and medical companies already dealing with Greek hospitals on a pay-as-you-go basis. Hospitals are short of the basics such as sutures and bandages, not to mention life-saving drugs.If Greece left the euro, Greek banks would immediately be completely destroyed. Business would grind to a halt, as there would be no way to roll out a new drachma overnight. There is no mechanism in place to do so. Things would eventually sort themselves out, but for the several months that the transition would would require there would be a real humanitarian crisis in a developed country, a phenomenon unprecedented in post-World War II Europe.Tsipras, with the political naïveté that only a new politician could muster, came into office thinking the Germans would blink because the threat of the eurozone breaking up would terrify them. He overplayed his hand. Now he is a dead politician walking. Relatively soon there will be a new Greek election. There is no way the Greek economy gets any better over the next few months, and voters will be looking for another option.Though I have little sympathy for radical socialists like Tsipras, I will admit to feeling sorry for him. He was in a no-win situation. Greek voters do not want to leave the euro, but they don’t want to have to deal with the realities of austerity that is European- (read German-) imposed.If Tsipras and Syriza actually took Greece out of the euro, there would be a massive voter backlash, because the economic reality on the ground for the year after exit would be quite ugly. No politician who wants to get reelected wants to inflict that kind of pain.Merkel and team knew Tsipras would have to cave at the end of the day. It is not that Angela Merkel is mean-spirited or wants to make the Greeks suffer. She has her own political realities to contend with. The odd thing is, the majority of German voters think they are the victims. They were innocents who goodheartedly lent Greece money, and now Greece doesn’t want to pay them back.There was a fascinating op-ed in the New York Times last week by Jacob Soll, a professor of history and accounting at the University of Southern California and the author of The Reckoning: Financial Accountability and the Rise and Fall of Nations. He talks about speaking at a conference in Germany where they were debating the Greek situation. I’m going to quote a little bit more than I usually do from someone else’s essay, because he conveys a serious point really well. He has spent much of the day listening to German economists before he rises to speak and debate on a panel.…but to hear it from these economists, Germany played no real part in the Greek tragedy. They handed over their money and watched as the Greeks destroyed themselves over the past four years. Now the Greeks deserved what was coming to them.When I pointed out that the Germans had played a major role in this situation, helping at the very least by insisting on austerity and unsustainable debt over the last three years, doing little to improve accounting standards, and now effectively imposing devastating capital controls, Mr. Enderlein and Mr. Fuest scoffed. When I mentioned that many saw austerity as a new version of the 1919 Versailles Treaty that would bring in a future “chaotic and unreliable” government in Greece – the very kind that Mr. Enderlein warned about in an essay in The Guardian – they countered that they were furious about being compared to Nazis and terrorists.When I noted that no matter how badly the Greeks had handled their economy, German demands and the possible chaos of a Grexit risked political populism, unrest and social misery, they were unmoved. Debtors who default, they explained, would simply have to suffer, no matter how rough and even unfair the terms of the loans. There were those who handled their economies well, and took their suffering silently, like Finland and Latvia, they said. In contrast, a country like Greece, where many people don’t pay their taxes, did not seem to merit empathy. It reminded me that in German, debt, “schuld,” also means moral fault or blame.When the panel split up, German attendees circled me to explain how the Greeks were robbing the Germans. They did not want to be victims anymore. While I certainly accepted their economic points and, indeed, the point that European Union member countries owe Germany so much money that more defaults could sink Germany, it was hard, in Munich at least, to see the Germans as true victims.Here lies a major cultural disconnect, and also a risk for the Germans. For it seems that their sense of victimization has made them lose their cool, both in negotiations and in their economic assessments. If the Germans are going to lead Europe, they can’t do it as victims.Admittedly, conferences tend to attract a focused group of attendees and are generally not representative of a population at large; however, the reaction he got is in line with the opinion polls I see coming out of Germany and other northern-tier European countries.Merkel will not remain popular if she is seen to be caving in to the Greeks. And so she dug in her heels. But at the end of the day she finally had to agree to lend the Greeks more money in order to maintain the appearance of a united Europe.But the agreement with Greece undermined, if not destroyed, the concept of European unity. Germany clearly dictated what were essentially unconditional surrender terms to Greece. One can be sympathetic to the German position that the Greeks have been profligate, don’t pay their taxes, need significant reforms, and on and on. But that doesn’t take away from the fact that the Germans who lent the money have benefitted from the system. The reality is that the Greeks owe something approaching one-half trillion euros to the rest of Europe. The Germans are going have to pick up about €200 billion of that, give or take.If Merkel had to deal with a €200 billion loss, her popularity would plunge. And there would be the risk that other countries would decide – perhaps on an emotional basis but decide nonetheless – that they would walk away from their debts owed to Germany as well. Germany is on the hook for multiple trillions of euros, just as I wrote some five years ago. The longer they keep lending money, not just to Greece but to the rest of Europe, the bigger the debt grows. What money are they lending, you ask? They are lending as part of their commitment to the European Central Bank and eurozone banking system and various European financial mechanisms. All that money is one day going to have to be accounted for, or the ECB is simply going to have to print a vast amount of money or guarantee an even larger pool to absorb all the debt.A fiscal union in Europe will require that nation-states will have to give up their fiscal sovereignty. Try sliding that past voters. You might get a significant number of smaller countries to do that, but can you really imagine France doing it? Seriously? Marine Le Pen is getting 40%-plus of the prospective vote today. Try getting the French to agree to give up to Brussels their ability to control their own budget and see how large her poll numbers get.My friend Eddy Markus and the rest of his team at ECR Research offered a good summation of where this leaves Europe. (I always make a point of getting Eddy to take me to lunch or dinner when I’m in Amsterdam. He has a way of getting the best tables with the most scenic views in really good restaurants – an excellent talent for an economist to have.) The bold print is from me.For the moment, Greece may have been saved from the abyss, but the underlying weaknesses of the Eurozone and the EU remain in place. Still, we do not think Europe will disintegrate for the foreseeable future. After all, the EU project is of eminent importance to the European leaders. It has boosted economic growth, there is an extremely low chance of war breaking out between the EU countries, former communist countries are functioning as democracies, and Europe counts for something around the world. This is not forgotten, and the EU leaders will not easily abandon the project.On the other hand, the Eurozone and the EU are no longer a byword for unity, prosperity, democracy, solidarity, and mutual respect. In essence, the project should be revamped to stop the rot, but this is unlikely to happen. After all, visionary leaders are lacking, and the sprawling structure of the EU is incredibly complex and often rigid. Reforms are years in the making.The most likely outcome is that the Eurozone and the EU will continue to muddle on. At the same time, there is a constant threat of disintegration and waning global influence. Europe also needs to narrow the gap between the economic viewpoints in the North and the South of the continent. Not to mention the rise of populism and the problems arising from Germany’s ascendant dominance. Such a climate does not seem to be conducive to euro strength.A geopolitical analysis of Europe's future underpins our economists’ opinion that the euro will have a hard time holding its own against the dollar in the medium to long term.

Don’t Bring a Knife to a Gunfight

For the next few years and maybe for the remainder of the decade, Europe will indeed continue to muddle on. The European Central Bank will try to paper over whatever problems they have. Greece will again go critical, if not next year, then the year after. If Schäuble is still around, he will again say that the Greeks have to figure out their own financing; and we will have another endless round of meetings with a lot of shouting and finger-pointing as they try to kick the can down the road one more time. That will continue to happen until one country or another finally reaches the endpoint and says, “We are out of here.”But when it happens, it won’t be a last-minute surprise. Greece taught a lesson to all those who might someday want to leave the euro. If you want to exit, then you have to plan for it. Waiting to the last minute is an absolute, utter, complete, total, (insert your own adjectives and expletives) disaster.If Tsipras had wanted to do more than bluff, he should have started contacting currency printers about printing his new currency. He should have been making real plans to exit. He should have told the voters that he was prepared to walk away from the euro. Of course, he could not have gotten elected if he had done that.So he walked into a poker game holding a pair of deuces and tried to bluff his way through. I know the rules of poker, and I have a lot of friends who play poker at a serious level, but I would have a snowball’s chance in Hades of walking into the World Series of Poker and not being blown out of the room. I might get lucky for a few rounds, but luck is not how you win that tournament. And you certainly don’t prevail by trying to bluff your way through. Germany knew that at the end of the day Tsipras was bluffing. And they held all the cards.Tsipras broke the first rule of politics: don’t bring a knife to a gunfight. This time, politics crushed economics. But my long-term bet is that economics wins. At some point some country is going to break from the herd, and we will once again see a multicurrency Europe. Or somehow countries will agree to give up their fiscal sovereignty, which means their own pensions and benefits will be at risk. Either way, it’s going to be a tough time to be a European politician.

New York, Maine, and Boston

I am going to close quickly because there is a party down at the pool, and I don’t want my hamburger to get cold. I will be home for the rest of the month, and then I’ll go to New York for a day or two before heading off to Maine with my youngest son, Trey (who is now 21) for our annual fishing trip with all my economist friends. Then later in the month I will go back to New York for a few days before heading off to Boston. I will have to figure out how to get up to Gloucester to see my friend Woody Brock, who is recovering from a freak medical problem that cropped up while he was in Europe and put him down for the count for the last month or so. The good news, he told me, is that he has lost a lot of weight. Then I will spend some time in Boston with Steve Cucchiaro, who has hopefully gotten his new boat ready for some mild sailing (I get seasick too easily for the rough stuff). I’m still working out my September schedule, but I’m goi ng to be all over the place. American Airlines loves me.Trey came over today asking me if he could get a shirt, as he had an appointment he needed to dress up for, and all of his were wrinkled or dirty. I took him back to my closet, and we found one for him, which fit perfectly. I know he walked away thinking “score,” as he now has a nice shirt, but I was thinking of the preteen who went on that first trip to Maine nine years ago. How did he get so big? And so fast? I might give up a shirt or two or three to see if I could get time to slow down.Have a great week. I hope you’re enjoying your summer, at least if you’re in the northern hemisphere. I understand from my Aussie friends that they’re suffering through a freak polar vortex in Sydney. Who knew?Your waiting for parity on the euro analyst,John Mauldin

“THE people have spoken. The bastards.” Dick Tuck’s reaction to defeat in a Californian state Senate race in 1966 is not that far from the attitudes of the authorities since the 2008 financial crisis. They have tended to act first, and hope that voters approve of their actions afterwards. Often this has involved the introduction of improvised measures that the people might not have favoured, and the use of bodies that were free from democratic constraint.The unpopularity of the Bush administration’s bank bail-out in 2008 created a strong sense of caution among elected leaders. Congress initially voted the rescue down in response to a backlash among constituents that eventually created the Tea Party. Although the bail-out was pushed though in the end, many of those who voted in favour lived to regret it.Given the public’s views, letting the central bank take the main role in generating economic recovery made a lot of sense. Getting Congress to sign up to further fiscal stimulus became impossible after the Republicans took control of the House of Representatives in 2010. The Federal Reserve kept interest rates at historic lows and unveiled further quantitative easing (QE) to drive down bond yields. Some Republican Congressmen still grumble about the Fed’s actions to this day but they have been powerless to do much about it.This shift of power is clear in the financial markets. For traders, what really matters are the decisions of Janet Yellen, the chairman of the Federal Reserve (and, before her, Ben Bernanke). The Fed has been hugely effective in shoring up asset prices; the fear is that when it starts pushing up interest rates, maybe later this year, markets will suffer. It is hard to think of a decision by Barack Obama or Congress that would be anything like as influential.In the euro zone, politicians fumbled and prevaricated but Mario Draghi, the president of the ECB, was the one who stopped the rot in 2012 with his “whatever it takes” speech about saving the currency. For European governments, institutional and democratic constraints ruled out what might have been the simplest solution: a write-off of debt and a direct transfer of funds from governments in Germany, the Netherlands and others to struggling countries like Greece and Ireland. Instead, European leaders created the European Financial Stability Facility (EFSF) and its successor, the European Stability Mechanism (ESM). They also summoned the help of the IMF, a body with much experience in sovereign rescues.These collective funds may have been approved by national parliaments but they resemble the kind of off-balance-sheet vehicles that were popular before 2007 in the American mortgage market. In the case of the EFSF, countries agreed to guarantee the debts of the vehicle, rather than put up hard cash (even if Eurostat does treat the guarantees as debt). For the ESM, euro-zone countries had to stump up €80 billion ($87 billion) in real money as initial capital but another €620 billion could theoretically be needed if the fund suffers losses. The amount of taxpayers’ money at risk was rather less clear to voters than it might have been.But that risk was very clear when EU negotiators were haggling with Greece about its latest bail-out deal, and helps explain why they were reluctant to accept debt restructuring. It was all very well for economists in America and Britain to urge a debt write-off but their countries’ voters weren’t being asked to take the hit. There were fine words from the IMF and the ECB on the need for debt restructuring—but no sign that they were willing for their own balance-sheets to be shredded.Democracy is a double-edged sword for economists to wield. There was much talk about the refusal of the EU to respect the wishes of Greek voters when negotiating the latest deal; rather less discussion of what voters in the creditor countries might have said had they been allowed to express an opinion on the negotiations. There is no easy democratic way of reconciling the wishes of voters in one country with those of another.Voters may also want inconsistent things: lower taxes, higher spending and a balanced budget at the same time. Politicians ought to make those tough choices. To the extent that they pass the buck to technocrats, or to international bodies making backroom deals, politicians lose control of their own destiny. Indeed, the feeling that their elected leaders are not in control may be one reason why voters in some countries are so angry, and are turning to parties outside the mainstream.

Stocks at the center of the economy are falling hard and charts suggest more weakness may be in store.

By Michael Kahn

Updated July 27, 2015 4:46 p.m. ET

When investors hear the term “industrials” they often think of the Dow Jones Industrial Average. However, the Dow of today is far from a measure on the industrial sector of the market and the economy. Just look at its components, which include Visa and Disney.So while the Dow is still officially in a trading range, the Select Sector SPDR Industrials exchange-traded fund is in serious retreat. And that does not bode well for the market and arguably for the economy a few months down the road.Though dominated by General Electric with its 10.2% weighting in the ETF, XLI still gives a good representation of what is happening to the sector. Peaking in February, the ETF has lost roughly 9% through Monday’s trading (see Chart 1). And this month, it joined utilities, energy and basic materials as the only ones with moving average death crosses in place. Each has its 50-day average below its 200-day average and that is not a healthy condition.

Chart 1

Select Sector SPDR Industrials

But the bad news on the technical front does not stop there. In June, it moved below chart support and during the market’s July rally it managed to reach that level once again – where it was unceremoniously stopped and fell away in a hurry. That is a classic example of a technical breakdown and test. Bears missing their chance to get out in June rushed in to sell when they had their second shot in July.Last month, about two weeks before the industrial ETF broke down, I wrote here that industrial metals miners, including copper miners, were acting bearishly (see Getting Technical, “Industrial Metals Slump Threatens Stock Market,” June 15). I called the entire basic materials group, which includes industrial metals, chemicals and “other companies that supply the basic inputs needed for manufacturing and other business efforts,” the bottom of the economic food chain. If that is true then industrials are the next level up. Weakness in basic materials seemed to lead directly to weakness in industrials and, taking that to its logical conclusion, that weakness should continue to spread. After all, other sectors rely on the industrial sector for their own inputs.The industrial sector is quite diverse and includes such industries as transportation, aerospace, commercial vehicles and heavy construction. Based on the Dow Jones U.S. sector indexes for each, the trends are down and the charts rife with breakdowns. The plight of the transportation sector is well known among even casual market enthusiasts. But last week’s earnings reports from such Dow components as Caterpillar and 3M certainly brought the rest of the sector’s weakness to the fore. Pundits will give the economic slowdown in China credit for at least some of the industrial’s decline. Indeed, the rapid drop in the Shanghai composite index since mid-June punctuated by Monday’s 8.2% thrashing agrees. But what I find more interesting is that the last time the market suffered a significant correction, aside from last year’s Ebola-inspired mini-panic, the industrials broke down first.

That was in the summer of 2011 and the industrial sector broke down about a week before the broad market did (see Getting Technical, “Industrial Stocks Are Shutting Down,” August 1, 2011). Although we cannot make a rule out of so few observations, it probably is a good idea to keep cash levels higher than normal.From the long-term view, the industrial ETF is now approaching a Fibonacci 61.8% retracement of its October 2014-February 2015 rally. It has already dipped below the major trendline drawn from the end of the 2011 correction although given the elapsed time and price movement involved I do not think this was a breakdown - yet. Should the sector keep falling, the breakdown would be undeniable and a move back to the October 2014 low would be in cards. That would be a drop of roughly 7% from current levels. Can it get there? That remains to be seen but it does seem that this is a weak sector without any technical reason to change anytime soon.

The recent steep decline of GLD price was supported by Chinese announcement that it holds only 1,658 tonnes of gold in its official reserves.

Gold declined below $1,100/toz, and GLD declined below $105/share.

It is questionable how reliable the information about Chinese official gold reserves really is.

There is a lot of gold in China that can be relatively easily used to boost the official gold reserves.

The current prices are an opportunity for long-term investors.

Gold prices have declined below $1,100 and the share price of SPDR Gold Trust ETF (NYSEARCA:GLD) has declined below $105. GLD made two unsuccessful attempts to break the $110 level over the past 9 months. The third one was successful. The main catalyst that helped it price to break the important support level was China's announcement that the country holds 1,658 tonnes of gold.

What is the problema?

The problem is that although China announced that its official gold reserves increased by 604 tonnes, or approximately by 60%, compared to the last public data released back in 2009, it is significantly less than expected. For example, Bloomberg Intelligence expected that the People's Bank of China holds gold reserves of 3,510 tonnes, and the World Gold chief economist at Australia & New Zealand Banking Group Ltd. predicted that China holds official gold reserves of at least 3,000 tonnes.Most of the analysts expected that the country hoards gold in order to back its currency. But that would take huge amounts of gold - gold that would be closed somewhere in the vaults of the People's Bank of China, which means that it wouldn't be present on the global gold market for sale. The supply would be tighter, which would support gold prices. The Chinese know this, they know the estimates of Bloomberg Intelligence and other banks and analysts, and they know that if they announce that the volume of their official gold reserves is significantly lower than expected, market participants will be shocked and the price of gold will decline. This may be the reason why they suddenly (after 6 years of silence) announced their official gold reserve figures. The timing was perfect. The gold price closed near an important support level at $1050 on Friday. During the weekend, China announced that it holds only 1,658 tonnes of gold, and the price of the metal declined below the $1,100 level (equivalent to GLD in the $105 area). The major support level has been broken, and some analysts predict that gold will decline below $1,000, which would mean that GLD will decline below $100 per share.Why would China manipulate gold prices? The answer is easy. To buy more gold at lower prices. If the country wants to increase the share of gold on its foreign exchange reserves to a level comparable to that of the Western countries, it will need to add thousands and thousands of tonnes. The current amount of 1,658 tonnes gold equals to 1.6% of total Chinese foreign exchange reserves (table below). To grow it to the Indian level of 6%, China needs to add 4,560 tonnes gold. To increase it to the Russian level of 13.4%, China needs to add 12,228 tonnes gold. And to get to the ECB level, the country needs to increase its current official gold reserves by 25,803 tonnes. Just for comparison, the World Gold Council estimates that there were 183,600 tonnes of gold in existence above ground. The 2014 global gold production was only 2,860 tonnes. If China really wants to increase the share of gold on its foreign exchange reserves substantially, it needs to acquire huge amounts of gold at as low prices as possible.

(Source: World Gold Council)

Is the number presented by the People's Bank of China reliable?Yes, it is. Maybe. Although the timing of the announcement is suspicious, the amount of reserves announced is surprisingly low, and it is in China's interest to suppress gold prices so that they can keep on buying cheap ounces, the number presented by the People's Bank of China may be technically correct. It is only statistics, and statistics can be manipulated easily.China is the largest gold producer in the world. All of the gold it produces stays in the country. Moreover, it keeps importing huge amounts of the metal. The chart below shows that the country's volume of net gold imports was growing at a rapid pace over the last couple of years. It is estimated that China mined and imported approximately 6,400 tonnes of gold between 2000 and 2013. Assuming that the 2014 numbers were comparable to the 2013 ones, the cumulative total is approximately 8,000 tonnes of gold.

(click to enlarge)

The above mentioned data show that there is a lot of gold in China. Although the official gold reserves are said to be only 1,658 tonnes, thousands of tonnes are held by the Chinese people. And huge amounts may be held by Chinese banks and large companies. The Chinese government and the regional governments may hold gold as well. This means that huge amounts of gold may be held by the Chinese government, although they are not a part of the official reserves. Of course, they could become a part of the official reserves easily, if needed. Also, the gold holdings of common people could easily be nationalized. USA is a country that tends to picture itself as the world's democracy number one. And it is a country that had prohibited its citizens from holding investment gold for a significant part of the 20th century. If a democratic country that declares that it protects freedom and ownership rights could nationalize the gold holdings of its citizens, a country like China, i.e. a communist dictatorship applying market economy, will have no problem in doing the same.In other words, yes, the official gold reserves held by the People's Bank of China may be only 1,658 tonnes right now. But the bank, in cooperation with the Chinese government is quite probably able to increase this amount substantially within a couple of minutes, hours or days by simply reallocating the gold held by Chinese institutions and individuals.

ConclusiónThe recent decline of GLD share price was supported by the fear that China isn't interested in buying gold as much as was originally thought. But the quite opposite may be true. There are some serious doubts that USA doesn't hold as large gold reserves as they claim to. And there are some serious doubts that China doesn't hold as small gold reserves as it claims to. I believe that the recent gold sell-off was fabricated to suppress gold prices, in order to acquire further cheap ounces. Although gold and GLD may decline further, the current low prices are a welcomed buying opportunity for long-term investors. Gold is a cyclical commodity, and the price of gold is currently too low. Some estimates say that one in 10 gold mines is operating at a loss right now. Taking into account all-in sustaining costs, the number should be significantly higher. This can't last forever.

Gold investors had high hopes for China, believing not only that its emerging middle class would be big buyers of the precious metal, but that the emerging superpower was quietly stockpiling its own version of Fort Knox in the vaults of the People’s Bank of China in Beijing.

But an announcement last week shattered that illusion. China’s central bank had bought only 604 tonnes of gold over the past six years — a sizeable chunk but nothing like the predictions of at least three times that amount that had been believed by many in the market.

The revelation that the amount of gold China’s slowing economy holds had actually fallen relative to its foreign reserves triggered an aggressive sell-off when markets reopened on Monday. For the pension funds, university endowments and savers who have all bought the metal in the past decade, as prices marched towards $2,000 a troy ounce in 2011, it may have been the moment when gold finally lost its charm.

In a matter of minutes almost $1.7bn worth of the precious metal was dumped after electronic and physical exchanges opened in New York and Shanghai, driving gold to a five-year low approaching the psychologically important level of $1,000 a troy ounce after months of trading in a relatively narrow band. Short-sellers, traders said, were trying to force increasingly nervous investors to capitulate.

“They’re basically saying we don’t believe the buyers can come out and defend their position,” said Joe Wickwire, manager of the Fidelity Select Gold Portfolio. “[They’re saying] we’re going to spook the market.”

That sinking feeling

The attack was well timed. Gold has been on the slide for several years. After hitting a record $1,920 in 2011 it has now slipped by 40 per cent. Half the gains it accrued between 1999, when the rally started at just $250 an ounce, have now been wiped out. This year should — by some accounts — have been good for gold. But despite the sort of bad news that would typically boost gold, including the Greek crisis, there has been little interest in what is supposed to be the ultimate haven investment.

“Gold has been the dog that did not bark,” says Matthew Turner, analyst at Macquarie in London. “It has always had a dual nature as a currency and a commodity. [But] at present it is not desired in either form.”

Investors have instead looked to the US dollar and Treasuries as safe places to park cash, driving the dollar to its highest level in 12 years.

After Monday’s sell-off, gold did not bounce back, eventually slipping at one point on Friday to a five-and-a-half-year low of $1,077. Traders are now questioning whether gold could fall back into triple digits for the first time this decade. An increase in US interest rates could sap demand for the metal as it increases the so-called “opportunity cost” of holding a non-yielding shiny rock. Goldman Sachs, one of the most influential banks in commodity trading, cautioned this week that it expected gold to fall to below $1,000 a troy ounce. Frederic Panizzutti, rated the most accurate forecaster last year by London’s bullion market association, estimates it will bottom at $950.

Others believe it will fall further. “As the Fed leads the way back towards normality, the gold price might return to levels of about $850 seen at the end of 2007 before the global financial crisis,” says Julian Jessop at Capital Economics. For savers and investors who bought gold, the metal’s promise as a safe haven looks tarnished. But for the gold mining industry the decline looks even bleaker: it threatens its very existence.

“There’s enormous pressure on the industry at these gold prices to deal with this now,” says Mark Bristow, chief executive of FTSE 100 gold miner Randgold Resources. “The industry has not been profitable for a while.”

The start of gold’s 12-year rally can be traced to a sale. Gordon Brown, the then newly installed UK chancellor of the exchequer, decided in 1998 to sell more than half of the country’s gold reserves. The metal had averaged less than $370 a troy ounce since the start of the decade and Mr Brown saw an opportunity to raise much-needed cash to fund the newly elected centre-left government. He was following the lead of other central banks who had been sellers of gold.The UK chancellor soon had reason to regret his move. At the start of the new decade a series of events helped trigger a multiyear rally. European central banks agreed to cap gold sales. The September 11 attacks set off a new era of heightened uncertainty in the world. And the enormous population of China underwent rapid industrialisation.By the end of 2006, with the US running a large deficit to fund conflicts in Afghanistan and Iraq, gold prices had almost tripled to $750 a troy ounce. The following year it broke through $1,000 for the first time ever, rising 30 per cent that year as the opening stages of the financial crisis unfolded. Gains averaged 15 per cent over the next four years until in 2011, buoyed further by the eurozone crisis and Arab Spring, the metal hit a record $1,920.

Hundreds of thousands of small investors had bought into the metal through the rise of so-called Exchange Traded Funds, which let a new breed of traders buy and sell small amounts of the metal. John Paulson, the hedge fund manager who made billions predicting the US housing crash, decided to denominate a large chunk of his assets in gold rather than dollars, making him one of the world’s largest owners of bullion. He argued that central banks’ decision to engage in quantitative easing, or “money printing”, would ultimately lead to the debasement of paper currencies and trigger Weimar-style inflation. But the idea that bullion would keep on rising proved false. With the $2,000 level in sight, gold suddenly stalled. Then it fell by $400 in little over a week in April 2013, the kind of move that would normally play out over a year, after Mario Draghi, the European Central Bank president, said he would do whatever it took to defend the euro. Traders initially said profit-taking was to be expected, but the market has never fully recovered. For the past two years it has settled into a relatively narrow range from $1,150 to $1,400, before this week when it dropped towards $1,000 for the first time since 2009.

Finding the bottom

Predicting where the gold price might bottom is difficult, says George Cheveley, a portfolio manager at Investec Asset Management. This is because gold is not like metals such as copper and zinc, which have industrial uses.“With other metals you can talk about production costs and fundamental demand. When it comes to gold it is a bit like a currency or a share — it is investor led. And that means it can overshoot,” says Mr Cheveley who runs the $220m Investec Global gold fund..

Gold bugs are, however, finding reasons to be positive. China, they believe, is not being truthful about how much gold it has bought because it wants to drive down the price and add to its reserves on the cheap. Some observers estimate its real reserves are closer to those of Germany at 3,400 tonnes and not the official number of 1,658 tonnes. “The bears have bitten on gold like a horse with a bit,” says Peter Schiff, who runs Euro Pacific Capital, an investment fund that specialises in attracting money from those betting that the US dollar will collapse. “Once people perceive that the dollar is more flawed than the yen or the euro, or any of the other currencies then where else can you go but gold. Gold will shine again.”The World Gold Council, the industry’s lobby group, rushed out a statement after the sell-off that claimed Chinese retail demand was still in “good health” and the growth trend intact.

The price of gold hit a five-year low of $1,088 a troy ounce on 20 July, falling 4 per cent in just a few minutes after the Shanghai gold exchange opened. The immediate cause of the drop was a surprise five-tonne sell order placed on the exchange by traders overnight.

“Over the past year, our physical gold sales in branches have not been very good,” says an employee at one of China’s largest state-owned banks in Shanghai, who asked to be called Mr Chen. “Gold prices had a big fall, no aunties have come to buy,” he adds, referring to the middle-aged women who were big buyers when the price last posted a big fall in 2013.But the gold bugs are not for turning: Texas-based former stockbroker Bill Holter believes it remains a buying opportunity. “I can calculate on the back of a napkin that China is buying more gold,” says Mr Holter, adding that import data supports his view. He also believes that gold will have its moment again when the world’s current build up of debt pops.“Mathematically it’s guaranteed to happen, it is just a question of when,” he says. “You cannot try to time gold. You just buy it and close your eyes and you know time is on your side.”Additional reporting Ma Nan in Shanghai and Owen Guo in Beijing.

Less than a decade after a housing/derivatives bubble nearly wiped out the global financial system, a new and much bigger commodities/derivatives bubble is threatening to finish the job. Raw materials are tanking as capital pours out of the most heavily-impacted countries and into anything that looks like a reasonable hiding place. So the dollar is up, Swiss and German bond yields are negative, and fine art is through the roof.

Now emerging market turmoil is spreading to the developed world and the conventional wisdom is shifting from a future of gradual interest rate normalization amid a return to steady growth, to zero or negative rates as far as the eye can see. Here's a representative take from Bloomberg:

For decades, central banks lorded over markets. Traders quivered at the omnipotence of monetary authorities -- their every move, utterance and wink a reason to scurry for safe havens or an opportunity to score huge profits. Now, though, markets are the ones doing the bullying.

The Fed's Countdown

Take New Zealand and Australia. Yesterday, the Reserve Bank of New Zealand slashed borrowing costs for the second time in six weeks even as housing prices continue to skyrocket. A day earlier, its counterpart across the Tasman Sea (already wrestling with an even bigger property bubble of its own) said a third cut this year is "on the table."

Just one year ago, it seemed unthinkable that officials in Wellington and Sydney, more typically known for their hawkishness and stubborn independence, would join the global race toward zero. But with commodity prices sliding, China slowing and governments reluctant to adopt bold reforms, jittery markets are demanding ever-bigger gestures from central banks. Even those presiding over stable growth feel the need to placate hedge funds, lest asset markets falter. When this dynamic overtakes countries such as New Zealand (growing 2.6 percent) and Australia (2.3 percent), it's hard not to conclude that ultralow rates will be the global norm for a long, long time.

Indeed, the major monetary powers that are easing -- Europe, Japan, Australia and New Zealand -- have all suggested rates may stay low almost indefinitely. Those angling to return to normalcy, meanwhile -- the Federal Reserve and Bank of England -- are pledging to move very slowly. Even nations with rising inflation problems, like India, are hinting at more stimulus.

"As interest rates continue to fall across most of the globe, central banks are also united in their main message: Once rates have come down, they're likely to stay down," says Simon Grose-Hodge of LGT Bank. "And when they finally do tighten, the 'normal' rate is going to be a lot lower than it used to be."

Could the People's Bank of China be next? "With underlying GDP growth still looking weak, more monetary policy moves are likely," says Adam Slater of Oxford Economics. "And China may even face the prospect of short-term rates dropping towards the zero lower bound."

This is not how the Fed, ECB or Bank of Japan envisioned the year playing out. They see ultra-low rates as an emergency measure, temporary in nature and to be dispensed with asap. From MarketWatch:

Federal Reserve policy makers are hoping, even praying, that no unexpected domestic development or international crisis intervenes to prevent them from taking the first baby step to normalize interest rates at the Sept.16-17 meeting.

Why? Fed officials point to a number of reasons: the unnatural state of a near-zero benchmark rate; the potential risk of financial instability; an improving labor market; diminishing headwinds; and yes, expectations of 3% growth just over the horizon.Fed Chairman Janet Yellen, usually considered a member of the Fed's dovish faction, sounded determined to act when she testified to Congress last week.

"We are close to where we want to be, and we now think that the economy cannot only tolerate but needs higher interest rates," Yellen said during the Q&A. "Needs," as in the patient needs his medicine.

What's the urgency with an economy chugging along at 2-something percent and low inflation? I suspect Fed officials are terrified of being caught with their pants down, in a manner of speaking. Should some unforeseen event come along to upend the economy, the Fed's arsenal would be dry. They'd like to put some space between their policy rate and zero.

That "unforeseen event" has arrived, leaving most central banks with a stark choice: Let the deflationary crash run its course at the risk of blowing up the quadrillion or so dollars of interest rate, credit, and currency derivatives hidden on bank and hedge fund balance sheets. Or push interest rates into negative territory pretty much across the developed world. Since option number one carries a statistically-significant chance of ending the modern financial era it is absolutely unacceptable to Goldman et al, and is thus a non-starter. Which leaves only option two: more of the same but bigger and badder.So...the central banks will panic. Again. Countries that retain some control over their monetary systems will see their interest rates fall to zero and beyond, while those that don't will be thrown into some kind of new age hyperinflationary depression. Not 2008 all over again; this is something much stranger.

Is it time to make negative interest rates a standard part of the central banker’s tool kit? A surprisingly large number of economists seem to think so.

Even before they finally decide that the time is right for liftoff, central bankers in the U.S. and the U.K. have been making it clear that in this cycle, their key policy rates will rise only gradually, and peak at levels well below those that were considered normal before the financial crisis.

But what happens if the U.S. and U.K. economies enter a sharp downturn in the next few years? That’s not an unlikely turn of events, since in both cases the current economic expansion is already relatively long lived.

With growth slowing, and inflation likely remaining low, policy makers might quickly be confronted once again with what is known as the zero lower bound–or ZLB. Until recently, it was thought that policy rates could not go negative, because there would be an immediate flight to cash, which can be thought of as a zero-interest bearer bond.

But then some European central banks started to set policy rates marginally below zero, and there was no widespread flight to cash or massive disruption of the financial system, probably because it’s quite costly and risky to hold cash in large amounts.

That experience has led economists to question the existence of the ZLB. According to a survey released earlier this week, a significant minority of U.K. economists now think that “materially” negative interest rates could be an option for central bankers, where “materially” means between 2% and 3%. Right now, the Swiss National Bank and the Danish central bank have gone furthest below the putative ZLB with deposit rates of minus 0.75%.

So there may be an alternative to quantitative easing, a stimulus policy which has its own limitations and downsides. Of course, a majority of the economists surveyed still think negative rates are a bad idea, including Nobel laureate Christopher Pissarides of the London School of Economics, who views such an option as weakening both the transparency and simplicity of current monetary policy frameworks.

But the same can be said for QE, and it no longer seems as “unconventional” as it once did.

China recently revealed that its own gold holdings haven't grown as much as expected.

But there's more to know about China's gold. And the truth reveals why you need to invest in gold yourself.

For stock market buffs, here's a blast from the past: the Plunge Protection Team. You remember those guys? That's the catchy nickname for a presidential group of officially sanctioned market manipulators who sprung out of Wall Street's 1987 crash, and who have been pulling strings and pushing levers behind the scenes ever since, to keep the markets from collapsing.Well, I'm not sure how to say "plunge protection team" in Chinese, but last week's news makes it clear: China has one. China released its latest data on the amount of gold its central bank is holding. The number was a shocking lie. And what seems clear in this lie is that China only released the data for one reason: to stanch the bloodshed in its stock market.I will tell you right now that if there's one investment you make this year, it should be gold -- physical gold. At just over $1,100 per ounce as I write this, gold prices are at the lowest levels since 2010. The latest move down stems from China's big, golden lie.The country announced last Friday that its official gold holdings now stand at 1,658 tons. That's just 600 tons more than the country supposedly owned in 2009. It's a lie as big as the country itself. China now mines more gold than any other country. It has mined more than 2,000 tons of gold since 2009. Much - if not all - of that gold ends up in the People's Bank of China.And depending on the month, the country is also the No. 1 or No. 2 gold importer. It has imported well over 3,300 tons of gold through Hong Kong. China has also imported nearly 700 tons from Switzerland since January 2012. And yet the country's official gold holdings increase by just 600 tons? The math seems askew.

And Then There's This Little TidbitJust last month, at the London Bullion Market Forum, the chairman and secretary general of the China Gold Association announced what should have been shocking news. It proves everything I've been saying for last few years about the massive size of China's gold hoard.Mr. Zhang's first slide showed that "Since 2009, Chinese gold reserves keep increasing. Successfully breakthrough 7,000 ton, 8,000 ton, 9,000 ton. Till the end of 2014, the gold reserves reach 9,816.03 ton, the world's second." (That's where he ended it, presumably meaning the world's second-largest hoard of gold.) I've been saying that based on known flows of gold, China has at least 5,000 tons and possibly closer to 10,000 tons. And here's the head of the country's gold association confirming my calculations and suspicions.And yet the country officially announced just a 600-ton increase that leaves the total hoard six times smaller than what the country's gold association says China really has. Why? Plunge Protection Team to the rescue!

A Secret Hedge Against a Dollar Disaster

During the recent Shanghai Stock Exchange implosion, there was an internal call for the government to shore up investor worries, not with empty words but with real action. One of those actions was to increase gold and silver reserves, to show that China's financial system is stable. Showing an increase in gold would help that cause.At the same time, the International Monetary Fund, which wants to add the yuan to a basket of reserve currencies, has been calling on China to update its accounting of its gold reserves, since that figure was last updated six years ago. Again, the latest announcement helps that cause. But it doesn't address the lie: Why would China so drastically under-report it's gold?There are two plausible scenarios I can think of:

China doesn't want to unsettle the global currency market by announcing how truly large its gold holdings are. That would call into question the value of U.S. dollars and could be seen as an attack on the dollar. China isn't ready - yet - to rule the roost.

China is preparing for a crisis of confidence in Western currencies, namely the dollar. And it is building a massive store of gold to fend off - and profit from - the storms to come. In a global currency crisis, gold would rise to between $3,000 and $5,000 an ounce, possibly more. The value of China's gold holdings - its real gold holdings - would recoup any losses accumulated in U.S. Treasury debt the country owns.

The Best Insurance Policy

This is the moment to be building your own hoard of gold. Prices are at five-year lows, yet nothing in the world has changed since the end of the global financial crisis.Indeed, far from deleveraging in the wake of the financial crisis, the world has actually taken on substantially more debt. This is not a sustainable path. And the payback will be painful. Buy gold, and buy it often. It's your only salvation when the reckoning comes.Until next time, stay Sovereign.

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.